U.S. to pump $250 bln into banks, economies struggle

WASHINGTON (Reuters) - The United States pledged on Tuesday to pump $250 billion into its banks, following similar action in Europe, but data showed the threat of recession has not been banished even if a financial sector meltdown has.

In Europe, major economies showed signs of flagging output and falling business confidence, but smaller countries also suffered acutely. Iceland sought to save its economy at loan talks in Moscow, while its stock market plunged 76 percent.

Under the U.S. Treasury plan, the government will buy preferred shares in qualifying financial institutions, with stakes in each limited to $25 billion.

U.S. Treasury Secretary Henry Paulson said 9 banks described as "healthy institutions" had agreed to accept government stakes for the good of the U.S. economy -- a state intervention unthinkable before a crisis widely compared to the great crash of the 1930s.

"Government owning a stake in any private U.S. company is objectionable to most Americans, me included.," he said. "Yet the alternative of leaving businesses and consumers without access to financing is to tally unacceptable."

President George W. Bush called it an essential step to ensure the viability of America's banking system,"

Federal Reserve Chairman Ben Bernanke promised continued action to stabilize financial markets.

"We will not stand down until we have achieved our goals of repairing and reforming our financial system and thereby restoring prosperity to our economy," he said in a statement.

The Treasury will buy stakes in Bank of America, Wells Fargo, Citigroup, JPMorgan Chase, Goldman Sachs, Morgan Stanley and Bank of New York Mellon Corp, two sources said.

Media reports said State Street Corp and Merrill Lynch would also receive a capital injection.

Similar moves in Europe helped restore confidence among investors on Monday.

London, Berlin, Paris and others pledged more than 1 trillion euros ($1.36 trillion) in direct capital injections for banks and to underwrite lending between banks that has all but frozen, choking off funds that drive business and industry.

"Day The Markets Breathed Again" ran the headline in Britain's Guardian newspaper above a photograph of the London City skyline, caught in a golden twilight.

Japan joined the global push, saying it could inject public funds into regional banks to make sure small firms can get cash.

Even the Gulf with its oil revenues is acting. The United Arab Emirates will pump 70 billion dirhams ($19 billion) of emergency funding into its banking sector.

"We see light at the end of the tunnel, but we are not there yet," European Commission President Jose Manuel Barroso told a news conference.

STOCKS SOAR BUT RECESSION A THREAT

Stock markets gave a thumbs up to government action. Japan's Nikkei surged more than 14 percent -- the biggest one-day gain in its history -- while European shares rose nearly 6 percent and U.S. stock futures had the Dow Jones opening sharply higher.

"Investors are peeping out of their bomb shelters," said Sean Callow, currency strategist at Westpac.

Many stock markets shed as much as 20 percent last week as panic gripped and experts said while financial meltdown may have been averted, the threat of a wide and deep recession had not.

German investor sentiment declined sharply this month, the heavyweight ZEW research institute survey showed, although many responses were given before Berlin's bank package was announced.

"The perspectives for the economic development in Germany have significantly deteriorated," the ZEW said in a statement.

The French economy contracted 0.1 percent in the third quarter, the Bank of France said and British inflation hit a 16-year high of 5.2 percent in September, although the Bank of England had anticipated the rise and the data are unlikely to prevent further interest rate cuts.

Former U.S. Federal Reserve Chairman Paul Volcker said the world's biggest economy was already in recession.

Trouble lurks in smaller economies too.

Officials from Iceland, driven close to collapse as frozen credit markets caused its banks to fail, are in Moscow for talks on an emergency loan that could be worth billions of euros.

Iceland's stock market plunged 76 percent as it resumed trading, having been shut since last Thursday.

MONEY MARKETS EASIER

Some relief was evident in money markets.

Libor rates for overnight dollars were fixed at 2.18125 percent, down from 2.46875 on Monday, while the interbank cost of borrowing three-month dollars had its biggest fall since March and three-month euros charted the largest fall this year.

In Britain, banks bid for less than half the 40 billion pounds of three-month cash offered by the Bank of England, suggesting the clamor for funds there had been reduced by the government's bank recapitalization plan.

But some 600 banks hoovered up 310 billion euros at a European Central Bank auction, rather than run the risk, as they might see it, of lending to each other.

Bush also said the Federal Deposit Insurance Corp will insure most new debt issued by banks and expand insurance to cover non-interest bearing accounts. He insisted the government's steps would be limited and temporary.

That move appeared aimed at unlocking credit markets.

The U.S. plan marks a quick about-face for Washington policymakers, who until recent days had been focusing on soaking up bad assets via a $700 billion fund approved by Congress.

(Editing by Ralph Boulton)